Microsoft shouldn’t hire any CEO who wants to kill Bing and Xbox

Analysts may push for it, but it will make the company weaker.

According to "people with knowledge of his thinking," Bloomberg is reporting that, should Stephen Elop become Microsoft's next CEO, he would consider shutting down or selling parts of the company to "sharpen its focus." The two divisions mentioned specifically are Xbox and Bing.

It's important to be a little wary of this kind of anonymous, unsourced commentary. It may not be accurate, and it may be agenda-driven. This kind of "thinking" appeals greatly to short-term investors who are more interested in boosting the next quarter's numbers than the long-term health of the company. The anonymous leak could, therefore, tend to make Elop seem more appealing to Wall Street.

Conversely, the leak shows a lack of strategic thinking and somewhat undermines the Xbox One, a product that launches in a couple of weeks. That's not likely to inspire confidence in a CEO candidate.

Nonetheless, analysts, in particular Rick Sherlund of Nomura Holdings, continue to encourage Microsoft to ditch these parts of the business.

Bing: Increasingly important infrastructure

The Bing situation is the clearer of the two. In the 2013 financial year, Microsoft's Online Services Division (as it then was) lost $1.3 billion. In 2012, the loss was about $1.9 billion (plus another $6.2 billion due to writing down the value of the aQuantive advertising firm). In 2011, it was about $2.7 billion.

As a standalone business, Bing is heading in the right direction, but for the time being, it is still a money pit. Getting rid of it would improve Microsoft's finances to the tune of about a billion dollars and change each year, something around a five percent improvement in operating income.

The problem with this superficial analysis is that Bing isn't a standalone business. I'm sure Microsoft would be happier if it could stand alone—if nothing else, it would help put an end to the "Microsoft should get rid of Bing" chatter—but there's more to the value and importance of Bing than just the bottom line.

Under this same facile analysis, Apple would sack everyone working on OS X, iWork, and iOS. After all, these three products are all given away for free. Apple has even warned that giving away the software is going to cut revenue by $0.9 billion. Software development at Apple is a money pit! Of course, nobody would actually make such an argument, because they would recognize that even if OS X, iOS, and iWork are not monetized directly, they still provide value to Apple as a whole.

So it is with Bing.

Data-driven services are becoming integrated operating system features. The best shipping example of this is probably Google Now, on Android. Google Now integrates data from a range of sources—both personal data, such as appointments and historic searches, and public data, such as sports results, traffic, route finding, and so on—to provide useful and relevant information proactively.

So, for example, Google Now will tell you that you'll have to leave now to get to your next meeting on time, given the current traffic, or that the exchange rate is exactly £1.00 : $1.60 when you're in London on holiday, or that you'd better pack an umbrella because it's probably going to rain today.

Apple's Siri is similarly data-driven, though arguably substantially less integrated.

These kinds of integrated services are increasingly important parts of modern operating systems, especially on highly mobile (and highly personal) smartphones and tablets.

Microsoft doesn't yet have anything as extensive as Google Now or Siri in its operating systems, but the company has started down that same path. Windows 8.1's search feature uses Bing to provide meaningful, structured search results. Bing also powers a number of apps, such as News and Weather. Windows Phone has extensive localized search capabilities, as befits a smartphone platform.

As these services become richer and more important, Bing will, accordingly, become more important. This infrastructural role may not be immediately reflected on the balance sheet, but it's an essential strategic investment. Bing is embedded into Microsoft's products. It can't be yanked out and sold.

Xbox: The part of Microsoft people actually love

The Xbox finances are a lot muddier. Sherlund claims that Microsoft loses about $2 billion a year on Xbox but manages to mask this entirely with $2 billion a year in Android patent royalties. While this was possible under Microsoft's old reporting structure, which grouped all of this revenue under Entertainment & Devices, Sherlund's claims are harder to reconcile with Microsoft's most recent figures, where licensing revenue and hardware revenue are handled separately, and one can't be used to offset the other.

According to the current reporting style, the Devices and Consumer Hardware business, which spans Surface, Xbox 360, and peripheral sales, third-party Xbox game revenue and Xbox LIVE subscriptions had a $0.2 billion gross margin on revenue of $1.5 billion. That's not as lucrative as the licensing segments, which, being software, have essentially zero marginal cost, but it's not the $0.5 billion per quarter that Sherlund thinks Xbox is losing, either.

The profitability of the Xbox business varies over the course of the year—it tends to do better at Christmas—and through the lifecycle of the console. Early units will be expensive to build, potentially even loss-making. Later ones will be cheaper to build. As the console grows older, more games will be available, and hence, more game revenue will be earned, too.

As long as the Xbox One avoids Red Ring of Death-style debacles, the Xbox One business should be profitable over its lifetime, if not from year one. If nothing else, between Xbox 360 and Xbox One, Microsoft should be able to attract 40 to 50 million Xbox LIVE subscribers, paying around $40 to $50 per year. That's about $1.6 to $2.5 billion for doing essentially nothing: it's money for old rope.

What it probably won't be is hugely profitable on the same scale as Office or Windows.

Is that a problem that justifies selling the entire division? That seems a difficult case to make. The Xbox brand is arguably one of Microsoft's best-loved. The Windows brand, for example, is strong, but among many, it's resented for real or perceived crashes and ease-of-use shortcomings. Xbox, as a gaming brand, has far more positive associations. If used effectively, that brand can be used to strengthen, for example, the Metro design language, and it can also help promote other subscription services such as Xbox Music.

If Microsoft wishes to keep its Devices & Services strategy, the Xbox division is important for that, too. It's the company's first device/service pairing, and it's a successful one.

The Xbox also continues to be valuable as a hedge against the possible (if unlikely) rise of smart TVs and streaming set-top boxes. Imagine if the oft-fantasized Apple-branded TV became a reality, going on to sell millions of units a year, promoting Apple's media marketplace, providing yet another avenue for app sales, and so on and so forth. With Xbox, Microsoft has an easy avenue into this market. Without it, it'd be another growth market that Microsoft blazed an early trail in, only to be absent once it takes off, just as with tablets and smartphones before.

This is not to say that this outcome is necessarily likely. But with Xbox being at least a little bit profitable, and with Xbox making the rest of the company look better, the case for getting rid of it seems non-existent.

Even if a good case could be made to scrap one or both divisions, there's a whole other problem. Other Microsoft products depend on Bing. They'd have to have this dependency unpicked and removed. And Bing and Xbox both depend heavily on Microsoft's products. Xbox One runs an operating system that's related to Windows 8. That operating system is used to support apps such as Skype and Internet Explorer to provide features that are, by all accounts, pretty cool. Microsoft is also pushing Azure computing to Xbox One developers as a core differentiator that PlayStation 4 has no equivalent to.

I don't think Microsoft has gone on record to describe exactly what technology underpins Bing, but it would be remarkable if there were not at least some degree of cross-pollination between Bing, on the one hand, and Windows, Hyper-V, and Azure, on the other hand.

This would make selling or spinning off either division tricky. Extracting them from the company, disentangling their software and services, looks difficult, perhaps even impossible. Divorce Bing and Xbox from Microsoft, and they become hollow shells of their current selves. Their software is essential, and their software is Microsoft software.

Even if the non-Microsoft Xbox company could take the software as it currently stands, without access to the Windows development tools, software platform, future software and service developments, and Azure, it's an Xbox company without a future.

Hiving Bing or Xbox off would destroy their value.

It's possible that this would provide a short-term boost to Microsoft's balance sheet. It's impossible that it would improve the company's long-term position. Anyone seriously proposing ditching these divisions isn't doing so because of a desire to improve the company. While shareholders might not care, the board sure should.